Valuing Companies Near Financial Distress
When a firm has too much debt, bankruptcy risk must enter the valuation. Going-concern value must be adjusted for the probability of financial failure.
FV, r, n) โ or type numbers directly: 10000 / (1 + 0.08)^1010000 / (1 + 0.08)^10A company drowning in debt is worth less than a healthy twin โ even if both have the same operating cash flows. The leveraged one might go bankrupt before those cash flows arrive. Financial distress has a real cost.
Value = Going-concern value ร (1 โ P(distress)) + Distress value ร P(distress). Distress value is what equity holders get after creditors are paid in liquidation โ often zero. P(distress) comes from credit ratings, CDS spreads, or Altman Z-Score.